Sundaram Finance: A long term compounder The demonstrated track record of stable and profitable growth across business cycles, established franchise with experienced senior management team, good overall asset quality makes Sundaram Finance a worthy inclusion in the portfolio. Sundaram Finance, the flagship company of the TS Santhanam arm of the TVS Group, is one of the oldest retail asset financing NBFCs. With a presence across diverse products, its primary focus is on financing of commercial vehicles and cars. The company, through its various subsidiaries, has a presence across multiple facets of the financial services industry, including housing finance, asset management and general insurance. It demerged its non- financial services investments in automotive and manufacturing businesses into a separate company: Sundaram Finance Holdings. It has demonstrated stable and profitable growth across business cycles, delivering mid-teen return on equity (RoE) for the past 10 years. Moreover, the company has delivered this growth without raising any equity capital for more than two decades. This judicious use of capital in creating a mini financial conglomerate is commendable and makes us look at the stock closely. Established track record in the vehicle finance business The company has a track record of over six decades in the commercial vehicle (CV) financing business. It benefits from strong parentage of the group, which is present across the value chain as automobile manufacturer, supplier to original equipment manufacturers (OEMs) and financier. The management’s experience and understanding of the target segments has enabled the company to deliver robust returns, while keeping asset quality under control over multiple business cycles. Asset under management (AUM) stood at Rs 24,734 crore as on March 31. The asset mix is diverse, with commercial vehicles (CVs) accounting for over half the book. The company has 622 branches but has traditionally maintained a larger focus on southern states, which accounts for about 65 percent of its asset portfolio. Stable asset quality: Sundaram Finance has consistently demonstrated strong and better- than-peer asset quality across economic cycles. Gross and net non-performing asset (NPA) ratios stood at 1.29 percent and 0.5 percent, respectively, as at March end. The company has been recognising NPAs on a 90-day basis ahead of regulatory requirements. Strong customer relationships, with around 60 percent of CV borrowers as repeat customers, provides the company an edge in maintaining portfolio quality over peers, especially in downturns. Prudent lending practices and sound collection systems have been the additional enablers of superior asset quality. Consistent profitability: Return on assets (RoA) fell to 2 percent in FY18 due to adjustment of dividend income from non-core investments following the demerger. Despite stiff competition from banks and other non-banking finance companies (NBFCs) putting downward pressure on yields, its margins have been resilient. Sundaram’s ability to obtain funds at competitive rates from diverse sources supports its margins. This along with superior operating efficiency and lower credit costs have resulted in the company reporting stable and comfortable profitability (RoA over 2 percent over the decade). Calibrated growth: Disbursement increased 19 percent year-on-year (YoY) to Rs 15,632 crore in FY18 despite facing disruptions caused by demonetisation and implementation of the Goods & Service Tax in the first half of FY18. Sundaram calibrates its growth strategy in line with market conditions and has not hesitated to curtail lending in times of heightened stress. While there is scope for widening and deepening its lending portfolio further, considering the group’s conservative approach, business growth is expected to be more measured over the medium to long term. Capital adequacy moderated after the insurance stake acquisition. However, its internal accruals are adequate for mid-teen growth in the loan book. Key subsidiaries Sundaram BNP Home Finance: The company’s housing finance business is conducted through a joint venture, with BNP Paribas holding 49.9 percent equity stake. Sundaram BNP Home remains a modest player in the housing finance segment, with operations largely restricted to the south. As on March 31, loan book stood at Rs 8,358 crore. The management was cautious while lending to this space given the rising incidence of NPA especially in non- housing loans. Following three years of decline in business volumes, disbursements grew a modest 5 percent in FY17. However, we are encouraged by its disbursements, with the business showing signs of a turnaround. Disbursements rose 43 percent at Rs 2,626 crore in FY18. Sundaram Asset Management: The asset management business is conducted through a wholly-owned subsidiary. Average AUM stood at Rs 35,982 crore as at March end, an increase of 27 percent YoY. We particularly like the asset mix, with its high fee earning equity assets at 51 percent of AUMs as at March end. Royal Sundaram General Insurance: Sundaram Finance originally had 49.9 percent equity stake in the non-life insurance business through a JV with RSA Group. It acquired the RSA Group's 26 percent equity stake in FY16, taking its total shareholding to 75.9 percent. The company has a modest market share of 1.74 percent and ranks 12th among general insurance companies. Royal Sundaram reported a 20 percent YoY increase in gross written premium to Rs 2,643 crore for FY18 and combined ratio improved to 109 percent from 111 percent in the previous year. Sectoral tailwinds is a key growth driver We are upbeat on improving fortunes of NBFCs in general and vehicle financing in particular. NBFCs have identified and created a niche in certain product categories (used CVs) and customer segments (small fleet operator and first-time buyer) of the CV financing business. NBFCs have an over 65 percent share in the overall CV market. While all segments of vehicle finance are expected to grow faster than before, CV financing, which constitutes 51 percent of the vehicle finance portfolio of NBFCs, is expected to rebound from the lows seen over the past several years and clock 14 percent CAGR till 2020, as per Crisil. The market opportunity for vehicle financing will stem from continued government investments in the roads sector, higher budgetary spends for the rural sector and expected finalisation of the scrappage policy or Voluntary Vehicle Modernisation Programme. The government’s focus on affordable housing through higher budgetary allocation for Pradhan Mantri Awas Yojana and multiple other schemes augurs well from a housing demand perspective. The gradual but steady shift of household savings away from physical to financial assets will be a key growth driver for the mutual fund industry. The trend, referred to as ‘financialisation of savings’ received a fillip after demonetisation resulting in a sharp uptick in inflows for the mutual fund industry. Reasonably valued with potential upside triggers Sundaram Finance, with diversified business segments, will be the key beneficiary of multiple growth drivers across various financial services. We expect the company to grow its lending book, albeit at a gradual and steady pace, improving RoE. Other businesses like AMC and general insurance are expected to grow in sync with India’s economic growth. We have valued the stock on a sum of the parts (SoTP) basis and see reasonable upside to the current market price. The company has demonstrated stable and profitable growth across business cycles, established franchise with an experienced senior management team, and robust asset quality makes Sundaram Finance a worthy inclusion in the portfolio. Investors with a long term horizon and wanting to participate in a steadily compounding diversified financial services company should buy into the stock. .